What Stocks Benefit From a Drop in Commodities
Original post by Slav Fedorov of Demand Media
Since commodities are basic materials used to produce goods, a drop in commodities would benefit most stocks by reducing input costs and boosting profitability, but the impact varies. Some companies are heavy commodity users: the cost of a specific commodity makes up a large part of their expenses. A drop in that commodity's price would reduce company expenses and boost profitability and subsequently the stock price. Since different companies use different commodities, it is important to link specific commodities to specific companies to accurately anticipate stock price moves.
Transportation companies such as truckers, airlines and cruise operators are heavy energy users. Their stocks benefit when the prices of gasoline and other fuels drop.
In addition to gasoline and other forms of fuel, oil is the basis for many industrial chemicals, so chemical producers generally benefit from lower oil prices.
The profitability of companies that make food products depends on the specific agricultural commodities they use. The link chain here may be a bit longer and less obvious. For example, a meat processing company depends of the prices of meat, which, in turn, are affected by the price of animal feed. Animal feed prices are based on specific agricultural crops. Good weather conditions can produce an abundant harvest in a particular crop, which would lower its price, which would lower the price of animal feed, which would lower the price of meat and meat products and boost the profitability of food companies.
Other Link Examples
Starbucks may benefit from a good coffee crop in Brazil; a real estate builder may benefit from lower timber prices; an electric utility may benefit from lower coal prices; an auto manufacturer may benefit from lower steel prices.
Some heavy commodity users protect themselves against rising commodity prices through futures contracts. If the price of a commodity reverses and declines instead, the user locked into higher prices through futures contracts will either have to continue to pay higher prices or suffer losses on its contracts. Either scenario will negatively impact profitability. Since use of hedging and hedging decisions vary from company to company in the same industry, a drop in the price of a commodity may benefit different stocks to differing degrees.
Establishing the Links
The more an investor knows about various business operations, the better he would be at establishing links between commodity prices and the users' stock prices. The key is that a commodity must account for a substantial percentage of a company's expenses; otherwise its impact is likely to be negligible. For example, many high-tech hardware manufacturers use precious metals such as gold and platinum to manufacture certain components, but the amount they consume is so small that even a substantial drop in the price of gold will not have much effect on computer or chip makers' stock prices.
- "The Wall Street Journal Guide to Understanding Money & Investing", Kenneth M. Morris, 2004
- "The All-Season Investor"; Martin J. Pring; 1992
About the Author
Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.